UK’s Endowment Mortgage

I learned about the Endowment Mortgage today for time.  What is an endowment mortgage?  This was a mortgage/ life insurance arrangement popular in the UK during the 1980s whereby a mortgage borrower would take an interest-only mortgage from a lender and subsequently invest in a whole life insurance policy from an insurer.  The idea was that the cash-flow that would normally go toward paying down principal on an amortizing loan would instead be diverted into the life insurance.  So long as the investments in the underlying life insurance policy did well the borrower could grow their assets quicker than they otherwise would have paid down principal putting them in a position to pay-off the mortgage in less time than the amortization schedule.

This is very simple to Doug Andrew’s philosophy that he made famous in book Missed Fortune.  When the financial markets act according to historical averages AND the borrower avoids any financial set-backs this can be a very good approach.  However, as we know now more than ever, there are many pitfalls to be considered.  First off, returns from investments, especially life insurance policies are not guaranteed.  Therefore, this approach can backfire quickly.  Second, long-term interest-only mortgage contracts are hard to come by these days and when they are they carry interest rates that are much higher than traditional amortizing mortgages.  Therefore, the consumer pays a premium for this payment flexibility.

Especially in today’s environment most consumers have a very low risk tolerance which makes this approach unsuitable.  However, if a consumer is financially savvy and understands the concept of financial arbitrage then a similar approach can pay-off in the long-run.

Do you have any experience with an endowment mortgage or something similar?  Please leave your comments below.